Thursday, October 23, 2008

The Debt Bubble Fantasy

Good Evening Everyone!

I hope everyone has had a great week. Its great to be back after some needed rest. A market like this can really wear you out. What a volatile week! It appears the market has temporarily come to a fork in the road.

The next step at this level is trying to figure out how bad the recession will be, and how much of it is priced into the market. The "bubble boys" seem to think we are in a bottoming process and are starting to nibble on stocks. The bears think there is a ways to go on the downside. This battle combined with high levels of fear and government intervention has created a market that's dominated by volatility and chaos.

The old saying used to be "bulls make money, bears make money, and pigs get slaughtered". They need to change this saying too "bulls lose money, bears lose money, and pigs get slaughtered (unless you were a a bearish pig)"!

The bulls are losing money obviously because we are down 40+% on the year in the markets. The bears are getting dinged as government interventional bounces continue to suck out trading accounts. As for the pigs? Well if you were a piggish bear, you are probably a millionaire by now!

The problem here is almost everyone is losing money. Hell, even the gold bugs are getting their butts handed to them as gold plummets! When everyone is getting crushed by the market, no one wants to participate because they are full of fear, and they don't trust the system

The bears have had it right in the current cycle, but most are too afraid to hold onto positions because of the constant interventions by the Feds. Many bears were wiped out by the two month mega Bear Stearns rally back in March. The ones left standing are still suffering from PTSD.

Now were there a few bear traders with steel balls who held onto their positions as the market moved down big from 10k to 8k? Yes, but I guarantee you most of them sold out much earlier and missed big profits. I sold many of my positions before getting to these levels because of interventional fear. I luckily held onto a few, but I honestly didn't have faith that the bets would pay off because this market no longer trades on fundamentals.

The stock market now trades based on how the government wants to intervene on any particular day. If they decide to announce a bailout or save a bank, the market rallies. If they stay out of the market for a day, the deleveraging of everything from hedge funds to banks continues and stocks tend to drop sharply.

What you are left with here is a market that is filled with corruption, intervention, confusion, fear, and fraud. As a result, it trades like a giant casino. When you buy a stock or a short ETF these days , you just hope its your lucky news day!

This is no way to invest people! If I want to gamble, I will head out to Las Vegas! This is why I continue to say that the best thing you can do with your money is keep it in cash until things mellow out.

The debt bubble dream world

The bottom line here folks is the debt bubble was nothing but a fantasy.

Lets take a look at incomes as the housing bubble peaked in 2006:

My Take:

Take one look at that graph and you realize that the housing bubble was not created based on fundamentally sound income growth like it usually does in a healthy market. Incomes were higher 8 years earlier in 1998 than they were when the bubble peaked in '2006! How could houses double and triple in value when incomes stayed the same? The answer is they can't.

This fantasy was created by the pigmen of Wall St. It was done via a combination of artificially low interest rates, bad lending standards, and the fraudulent "financial innovation" of leveraged finance on Wall St.

Bottom Line:

We are now entering the next phase of the debt bubble blowup. I will call this the blame game phase. The market attempted to keep the debt bubble fantasy going via huge liquidity injections from the government. This has failed miserably and the market is now realizing it.

Now that the market understands that the game can no longer continue, its time for the fallout. This is where the lawyers will have a field day. It started with AIG and Lehman(Fuld) last week. Today, Greenspan got reemed by Congress for creating this mess via with his horrible low interest rate policies. Expect many more hearings on this debacle followed by criminal trials as the market continues to suffer.

Stocks are now in the process of being repriced as the market accepts the fact that the debt bubble has burst and is not coming back. This is going to take awhile because so much damage has been done. To make things worse and even more confusing, stocks must also be repriced based on the reality that we are now in a recession that will last at least through 2009.

My belief is we still have further to go on the downside. The credit markets are still too tight, and earnings expectations by the analysts are still way too high going forward. I believe that at the least, we will test the S&P lows of the last recession which was around 800.

I expect a lot of choppiness before we get there, and there is a good chance that we head lower from there. The best thing from an investing standpoint is to stay in cash with your core long term assets until we begin too see a trend here. I expect we may trade sideways here for awhile. The range should continue to be large as the VIX continues to stay at elevated levels. Volatility will rule with an iron fist!

If you are a trading addict, use the volatility to your advantage. I have had some good success shorting the interventional bounces that we see on a weekly basis. For example, Monday created a great entry point for some short positions.

Enter these at your own risk, stay nimble, and be prepared to hit the sell button. Take profits and get out quickly on a nice plunge like we had on Tues. This market is fast and profits can be lost in minutes.

Right now I am sitting on the sidelines looking for some better entry points.

Stay Tuned!


ZMonet said...

How was Florida? See anything of interest?

My brother-in-law just got let go from his construction job in the mid-west. This was/is a guy who had absolutely ZERO to do with the excesses of The Bubble -- drives a $5000 car, rents a $800/month apartment and basically doesn't waste any money -- yet he will be hit hard by the need for people to live in McMansions they couldn't afford and Wall St. greed. If I was him, I'd be real pissed, but he needs so little to live on to make him happy that, at least for the moment, he doesn't stress about it.

Jeff -- one point of clarification, and maybe you answered this before, but when you say that your longterm assets are cash, are you advising that people liquidate 401Ks, stocks, etc. that they plan on holding for the 20-40 years?

Jeff said...


Florida was great. Lots of cranes and half built buildings down there though.

It looked like many of the projects must have been put on hold or the builder ran out of money. Kinda eery actually

I saw a lot of foreclosure signs.Talked to a friend in Stockton Cali. She said half the houses are for sale.

Regarding 401k's, getting out now doesn't make much sense with a 20-40 year horizon.

If you aren't sleeping well at night because of this and you are young then put some in a money in whatever your 401k has available thats fixed income. Bonds or certian money markets like Vanguard which are made up of treasuries and avoided suubprime.

I advised many people on here to get into cash before stocks really dropped, so if you got out at DOW 13 or 14k, I would stay in cash.

This has a long ways to play out so there is no rush to go long equities. This will be an L shaped recession versus a V.

There will be no bull rally off the lows like the one seen in 2003.

Too much damage has been done. It will take years for investors to trust the system. We will recover eventually, but fixed income couod outperform stocks for years going forward.

I say this because interest rates will eventually rise dramtically to fight all of the inflationary bailouts that we have done over the last few months.

We could end up with 8% savings accounts like we saw in the Volker years in the early '80's. That is a ways down the road though.

One of my advisors explained to me that in the 1070's that all of the pigmen got out of the stock market and into fixed income because thats where the money started going because stocks didn't budge for 10 years.

You could see another mass exodus into fixed income like bonds once again. The new economy will be nothing like the one we have seen since the mid '80's.

Stocks will be out of favor for a long time IMO. Time will tell if I am right.

Jeff said...

oops 1970's, not 1070 above..Darn typos!

Jeff said...

Not liking the news flow tonight everyone.

Treasury failures are increasing:

"The credit crisis is causing a growing number of delivery failures with Treasury securities.

The latest data from the Federal Reserve Bank of New York showed that cumulative failures hit a record $2.29 trillion as of Oct. 1. The federal settlement period is T+1 (trade date plus one day).

The outstanding U.S. public debt is $10.3 trillion.

"Current [fail] levels are at historic levels," said Rob Toomey, managing director of the Securities Industry and Financial Markets Association's funding and government and agency securities divisions. "There's been significant flight to quality" with the market turmoil, he said."

Jeff said...

Roubini is warning of a bank shutdown.

The more I catch up on the news flow this week, the more I want to throw up

Take some money out of the bank this week in case this goes down. Take out enough to last you for two weeks.

Geez this is just getting crazy:

``Systemic risk has become bigger and bigger,'' Roubini said at the Hedge 2008 conference. ``We're seeing the beginning of a run on a big chunk of the hedge funds,''
and ``don't be surprised if policy makers need to close down markets for a week or two in coming days,'' he said.

Roubini predicted in July 2006 that the U.S. would enter an economic recession. In February this year, he forecast a ``catastrophic'' financial meltdown that central bankers would fail to prevent, leading to the bankruptcy of large banks exposed to mortgages and a ``sharp drop'' in equities."

Mat said...

"This fantasy was created by the pigmen of Wall St. It was done via a combination of artificially low interest rates, bad lending standards, and the fraudulent "financial innovation" of leveraged finance on Wall St."

Jeff, you hit the nail on the head.

It is not the first time that "markets" were being "created" to maximize profits. The dot-com bubble worked like that and even the "exotic car boom" at the beginning of the nineties. I do not think people realize how much "demand" can be/is manipulated through influence, money and creating a certain atmosphere and financial "trends". Just before the dot-com market collapsed I read one of those "scientific" investment papers sold by Merrill Lynch at about $300 a copy preaching " 50% growth, bla, bla". This paper proved to me what this was all about: creating and promoting their own business as bank/investment and IPO managers.
So, what to do after the dot-com crash? Just create a new vehicle that will grant you 15-25% interest rates/profit again.

The other problem is competition. If other market players make horrendous profits through certain (even illegal) deals it is difficult to resist the pressure. If other banks do not participate in this game they risk loosing value on the stock market, being downgraded by rating agencies and afterwards swollowed by the "sharks"

Regards from Germany (where banks sold Lehmann certificats as "conservative, 100% save" investment to old folks even though they knew that certificates are not covered by the german FDIC)

Jeff said...


Great points. Its great to hear some opinions from Germany!

I totally agree! Your country seems to be doing the best during this downturn.

I wonder what the next bubble might be? Alternative energy?

I am sure Wall St will desperately try to find another illegal money machine.

I think its going to take awhile as the regulators rip them to pieces.

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